Why build up a precautionary savings?

Urgent repair, unforeseen medical expenses, sudden loss of income… Each of us may, one day or another, be confronted with unforeseen events leading to unexpected expenses. Having a precautionary savings proves to be very valuable to absorb the financial impact and to face the situation calmly. What is it, how to set it up and what amount to put aside? myLIFE shares some recommendations with you.*

Sophie and Arthur, 26 and 27 years old, have been living together for two years. They both work, but between the rent, outings with friends and the repayment of the loan they contracted to furnish their apartment, they have not found the opportunity to save. And then one day, their car breaks down. Certainly, it was no longer very young, but they really did not expect it. The problem is that Sophie has an imperative need for a vehicle to work. Verdict of the mechanic: €2,800 in repairs. A hard blow for our young couple who have no money set aside. And even less to buy a new car.

After a few days of stress, Arthur’s parents propose to lend them this sum of money. Phew! But this mishap incites them to take their financial future into their own hands. They have learned their lesson. Before going to see their banker to plan their financial future, they decide to build up a safety savings so as to be sure to be able to assume unexpected expenses in the future.

What is precautionary savings and why is it important?

Precautionary savings is a sum of money that is put aside in order to face financial unforeseen events: a major repair on a vehicle, a temporary loss of income, a washing machine that gives up, urgent dental care, etc. It allows one to assume exceptional costs without risking being overdrawn, resorting to credit or borrowing money from relatives. It also avoids having to draw from long-term savings or threatening the realization of projects (travel, real estate, retirement, etc.).

This financial reserve plays a key role: it protects against hard blows and brings increased serenity. Precautionary savings can be considered as a kind of personal insurance that allows anticipating the hazards of life.

It is obvious that if Sophie and Arthur had had one, they would have approached this situation more calmly. The amount of the repairs of their car would nevertheless have been a very bad surprise, but they would have been reassured to know that they had enough to assume their obligations.

Precautionary savings is secure and liquid savings. It is placed in a guaranteed capital account (not subject to market fluctuations) and available immediately.

How to build up a safety savings?

To reach their savings goal, Sophie and Arthur will have to save regularly, even small amounts, in order to build up their reserve. They begin by reviewing their budget by laying out their income and all of their expenses. They take advantage of this to identify purchases they could do without. They are right to try to reduce costs as much as possible!

To help them discipline themselves and determine the amount to place each month, they use the 50/30/20 budget approach: 50% of their income will be devoted to expenses related to their essential needs and obligations (housing, food, energy bills, etc.), 30% to pleasure purchases and leisure (outings, restaurants, etc.) and finally, 20% to their precautionary savings. It may be a little ambitious, but why not try?

To be certain not to forget their good resolution, they program an automatic transfer at the beginning of each month of the amount to be saved from their joint account to a dedicated savings account. Thus they build up their capital, without thinking about it anymore. If they had chosen to wait until the end of the month to put aside what remains, they would probably have succumbed to the temptation to put more into pleasure purchases.

Note: Precautionary savings is secure and liquid savings. It is placed in a guaranteed capital account (not subject to market fluctuations) and available immediately. The objective is that it can be used quickly in order to face an urgent expense. As this sum is not supposed to be used regularly, it is recommended to place it in a remunerated savings account, rather than in a current account which often does not pay interest.

=> Safety savings must only be reserved for unforeseen expenses. Sophie and Arthur must not draw from it for leisure or longer-term investments.

What amount to save?

It has now been several months that Sophie and Arthur have been saving. At first, they had to tighten their belts and make efforts, because they also had to reimburse Arthur’s parents for the car repairs. But now, putting money aside has become a routine. They are however questioning themselves about the amount to save. How far must one be able to assume an unforeseen event?

It is often recommended to keep between 3 and 6 months of salary, but the sum varies from one household to another. It depends on income, fixed costs, but also on the family and professional situation of each. A single employee without children, who rents his apartment, will certainly have less important financial needs than a couple with two children, owner of a house.

Our young workers must also not lose sight of the fact that the goal of this approach is both to be able to face unforeseen expenses, but also to guarantee their peace of mind. Some people will feel reassured with €3,000 set aside, while others will need triple to sleep soundly. The psychological dimension must not be neglected.

If part or all of the precautionary savings has been used to cover unforeseen expenses, rebuilding this reserve before any other investment (real estate, retirement, etc.) allows guaranteeing your serenity before investing yourself in new projects.

Sophie and Arthur will thus have to determine the minimum sum of money that will allow them to approach the future in complete serenity. They begin by estimating the monthly amount necessary to cover their essential expenses (inevitable charges, excluding leisure). They then multiply this amount by the number of months they would like to be able to cover in case of financial difficulties (loss of employment of one of them, for example).

They can also adjust their savings by taking into account the specific risks to which they are exposed. Being currently tenants, they will not have to worry about anticipating major real estate works or, for example, the replacement of a defective boiler. On the other hand, unlike a couple who does not own a car, they know that they will, at one time or another, be confronted with new repairs on their vehicle. They will one day even have to buy another one, but such an expense is not covered by precautionary savings. It is a project in its own right that requires a specific budget or the subscription of a personal loan from their bank.

Note: To stay in phase with their needs, Sophie and Arthur will be led to make their precautionary savings evolve according to changes in their personal situation and their lifestyle: variation of their income, real estate purchase, birth of a child, etc.

=> Precautionary savings is maintained over time. If part or all of the kitty has been used to cover unforeseen expenses, rebuilding this reserve before any other investment (real estate, retirement, etc.) allows guaranteeing your serenity before investing yourself in new projects.

And afterwards?

Thanks to their efforts, Sophie and Arthur now have a safety cushion allowing them to envisage the future with more serenity. Precautionary savings constitutes the basis of the management of their assets (see the principle of the investment pyramid). They will now be able to place their money in medium- and long-term savings products, thus protecting themselves and their relatives: life insurance, retirement provision, mortgage savings, etc. According to their objectives and their risk profiles, they will afterwards be able to turn towards more risky and potentially more profitable investment products. Solutions exist at each stage and they can rely on experts to accompany them.

They therefore decide to approach their banker in order to discuss with him the options available to them. He will be able to accompany them in the management of their money and help them to realize their life projects. This is true for them, but also for you. Whether one lives alone or as a couple, with or without children, everyone has the right to a solution adapted to his reality and to his needs.

* Content translated from French by the BIL GPT AI tool